Wednesday, September 30, 2015

Year-End Tax-Planning Considerations for Those About to Get Married


As if the process of getting married isn’t complex and difficult enough, prospective spouses also need to take income tax considerations into account before tying the knot.
That’s particularly true for those who plan to marry late this year or early next year. From the federal income tax standpoint, those marrying next year may come out ahead by deferring or accelerating income, depending on their circumstances. Others may find it to their advantage to defer a year-end marriage until next year.
The timing issue—whether to marry this year or the next—may be particularly relevant for same-sex couples in light of the recent decisions by the Supreme Court. In Obergefell v. Hodges, the Supreme Court held in June that same-sex couples may now exercise the fundamental right to marry in all states. Previously, in the 2013 decision U.S. v. Windsor, et al, the Supreme Court struck down section 3 of the Defense of Marriage Act, which had required same-sex spouses to be treated as unmarried for purposes of federal law. The IRS subsequently issued guidance on this decision in which it determined that same-sex couples legally married in jurisdictions that recognize their marriages will be treated as married for federal tax purposes, regardless of whether their state of residence recognizes their marriage.
Background: The amount of income subject to the two lower tax brackets (10 percent and 15 percent) for married taxpayers filing jointly is exactly twice as large as the amount of such income for single taxpayers. However, the tax brackets above 15 percent cover a larger total amount of income for two single taxpayers than for two taxpayers who are married.
For example, in 2015, two unmarried taxpayers can each have $90,750 of taxable income before they hit the 28 percent bracket. On the other hand, if they are married, their combined taxable income over $151,200 will be taxed at a rate starting at 28 percent. Also, on a joint return, the 33 percent rate begins at $230,450, the 35 percent rate starts at $411,500, and the 39.6 percent rate starts at $464,850.
On the other hand, two unmarried taxpayers with substantially equal amounts of income can have as much as $378,600 ($189,300 × 2) of taxable income before being in the 33 percent bracket, $823,000 ($411,500 × 2) before being in the 35 percent bracket, and $826,400 ($413,200 × 2) before being in the 39.6 percent bracket.
Thus, there is a marriage penalty when, for example, married taxpayers’ combined income will cause part of their income to be taxed at a rate above 25 percent, when none of their income would be taxed at a rate above 25 percent if they filed as single individuals.
A taxpayer’s marital status for the entire year is determined as of Dec. 31. A taxpayer who gets married (or divorced) on that date is treated as if he were married (or single) all year long.
Marriage-penalty implications for year-end planning: Those eager to tie the knot as soon as possible should keep in mind that deferring the marriage until next year could save substantial tax dollars. And, where two unmarried taxpayers with substantially equal amounts of taxable income have solidified plans to marry next year, it may pay to accelerate income into this year rather than attempt to defer it until next year.
Illustration 1: John and Jess are planning to get married. Jess expects to have $300,000 of taxable income in 2015, and John expects to have $250,000. Their combined taxable income for 2015 will be $550,000. If they get married before 2016, and file a joint return for 2015, they will owe income taxes for 2015 of $163,715.90. If they delay their marriage until 2016, then for 2015, Jess will owe taxes of $82,606.25, and John will owe $66,106.25, for a combined tax of $148,712.50. This will be $15,003.40 less than they would owe if they married in 2015 and filed a joint return for 2015.
If John and Jess married in 2015 and filed separate income tax returns for 2015, John would owe income taxes of $71,957.95 on taxable income of $250,000, and Jess would owe income taxes of $91,757.95 on taxable income of $300,000. The combined amount they would owe would be $163,715.90, the same amount they would owe if they filed a joint return for 2015.
Marriage bonus implications for year-end planning: If only one of the prospective spouses has substantial income, marriage and the filing of a joint return will usually save taxes, thus resulting in a marriage bonus. In such a case, it will probably be better to defer income until next year if they will be married next year, or, if they are in the planning stage, to accelerate the marriage into this year if feasible.
Illustration 2: Same facts as in Illustration 1, except John expects to have taxable income of $25,000 in 2015, and Jess expects to have taxable income of $525,000. If they get married before 2016, and file a joint return for 2015, they will owe income taxes for 2015 of $163,715.90. If they delay their marriage until 2016, then John will owe income taxes of $3,288.75 for 2015, and Jess will owe income taxes of $164,269.05. Their combined income taxes will be $167,577.80 in 2015 if they file as single taxpayers, or $3,841.90 more than they would pay if they filed a joint return for 2015.
Depending on the taxpayers’ income, marriage and the filing of a joint return may not only result in a marriage bonus because of the tax-rate structure, but also produce tax savings in the form of bigger deductions based on adjusted gross income, or smaller AGI-based tax hikes. For example, for 2015:
• The AGI phaseout for making deductible contributions to traditional IRAs by taxpayers who are active participants in an employer-sponsored retirement plan begins at $98,000 of modified AGI (MAGI) for joint return filers and the deduction is phased out completely at $118,000 of MAGI. For single taxpayers, the phaseout begins at $61,000 of MAGI and is phased out completely at $71,000 of MAGI. And for a married taxpayer who is not an active plan participant but whose spouse is such a participant, the otherwise allowable deductible contribution phases out ratably for MAGI between $183,000 and $193,000.
• Individuals may take an above-the-line deduction for up to $2,500 of interest on qualified education loans, but the amount otherwise deductible is reduced ratably at modified AGI between $130,000 and $160,000 on joint returns, and between $65,000 and $80,000 on other returns.
• The 3.8 percent investment surtax applies to the lesser of (1) net investment income or (2) the excess of MAGI over the threshold amount of $250,000 for joint filers or surviving spouses, $125,000 for a married individual filing a separate return, and $200,000 for other taxpayers.
• The additional 0.9 percent Medicare (hospital insurance) tax applies to individuals receiving wages with respect to employment in excess of $250,000 for married couples filing jointly, $125,000 for married couples filing separately, and $200,000 for other taxpayers.
Besides the above considerations, couples thinking of marrying should consider there are various tax rules that apply differently to related parties, and that, when one marries, his spouse becomes a related party. For example, there is a rule that doesn’t allow someone to recognize a loss on a sale to a related party. Using that example, a couple may want to consider having an intra-couple sale occur before the marriage takes place.

Tuesday, September 29, 2015

Alternative Minimum Tax: What Is It and Do You Need to Worry About It?


There are two ways the IRS can calculate your federal income tax liability each year -- the standard method of using deductions, exemptions, and credits to determine your marginal tax rate or tax bracket, and a completely separate method called the alternative minimum tax, or AMT. More and more middle-class households are blindsided by the alternative minimum tax each year, so here's what you need to know about the tax and who it applies to.
What is the alternative minimum tax?Basically, the alternative minimum tax is intended to ensure that high-income individuals can't use excessive deductions and exemptions to avoid paying their fair share of taxes. The tax has existed since 1969, and was originally aimed at top income earners who derived all of their income from tax-free bonds in order to avoid paying any taxes whatsoever.
At first, the tax made a lot of sense. It originally targeted people who earned over $200,000 per year, which was a massive income in 1969. Fast-forward 46 years, and the AMT thresholds now include many middle-income families.
Will you have to pay it?Whether or not you'll have to pay alternative minimum tax depends on a few factors. Of course, the primary factor is your income. And, while it seems that earners in the $200,000 to $500,000 income level are most vulnerable, it's possible to get hit with an alternative minimum tax with an income greater than $83,400 for married couples and $53,600 for single taxpayers.
Other than income, the main determining factor is how many exemptions and deductions you have. For instance, if you have a bunch of kids, high medical expenses, and you have lots of miscellaneous itemized deductions, it's entirely possible to earn a six-figure salary and have zero federal income tax liability under the standard calculations.
However, your tax will be calculated using both methods -- the standard formula as well as the alternative minimum tax. If the alternative minimum tax is more than the standard calculated tax, you're responsible for paying the difference.
How is it calculated?The calculation of alternative minimum tax is complicated (then again, what isn't complicated about the U.S. tax system?)
When calculating alternative minimum tax, a completely different set of exemptions and tax rates are used. The calculation starts with your regular taxable income, and then certain deductions are added back in. For wealthy taxpayers, deductions related to incentive stock options and tax-exempt interest from certain private activity bonds are added back, but there are many deductions commonly taken by middle-income taxpayers that are not allowed in the AMT calculation. Just to name a few examples of deductions that are not used when determining income for alternative minimum tax purposes:
  • Deductions for state and local taxes you paid
  • Miscellaneous itemized deductions -- this category includes deductions for unreimbursed employee expenses, tax preparation fees, and several other expenses.
  • Property taxes
  • Home equity loan interest, unless the loan funds were used exclusively for home improvements
Once the income subject to alternative minimum tax is calculated, an exemption amount is applied, which is $83,400 (married filing jointly) or $53,600 (single/head of household) for the 2015 tax year. The remaining amount is subject to tax rates of 26% or 28% depending on how much the income is, and if the income is high enough, the exemption amount begins to phase out. I know this sounds complicated.
f this still sounds complicated, don't worry. Few people actually calculate their AMT by hand. If you use a computer program to do your taxes, all of the major ones calculate the alternative minimum tax automatically. For the few people who prefer to do taxes by hand, the IRS provides an AMT assistant to help determine whether you should even fill out the AMT form.
Smart tips to reduce your alternative minimum taxThere may be a few ways to reduce the likelihood you'll get hit with the alternative minimum tax, or at least reduce the amount you'll have to pay. To get you started:
  • Increasing your 401(k) contributions can help reduce your taxable income, and you can choose to defer $18,000 of your paychecks into your account in 2015 ($24,000 if you're over 50).
  • Make sure your tax-free municipal bonds are AMT-exempt. Your financial advisor should be able to find this out quickly, and many bonds are actually advertised as "AMT free."
  • Maximize your business tax deductions. If you file a schedule C, the deductions you claim are not affected by the alternative minimum tax calculations.
The bottom lineThe alternative minimum tax has good intentions -- to make sure that loopholes don't allow the wealthy to avoid paying their fair share of federal income taxes. However, since the AMT thresholds are now in the realm of middle-class household incomes, it makes sense to familiarize yourself with the alternative minimum tax calculation process and whether it could affect you.

Monday, September 28, 2015

Capital losses can save on taxes

With the end of 2015 approaching, you may be assessing your personal income tax situation and looking for tax planning strategies that will work to your favor. Have you considered the potential for tax savings related to capital gains and losses?
Most taxpayers understand that their income levels and filing status determine their marginal (ordinary) tax bracket, with tax rates ranging from 10 percent to 39.6 percent. These tax rates apply to sources of ordinary income, such as salary, self-employment income, business income, interest income and certain sources of retirement income.
However, capital gain income may be subject to rates that are lower than ordinary tax rates. Capital assets commonly include property held for investment, such as stocks, bonds and mutual funds. The tax rate on long-term capital gains can range from zero percent to 20 percent, depending on your taxable income.
Awareness of the different tax rates and evaluating the nature of your capital gains can help you take advantage of the preferential capital gain tax rates, utilize capital losses to offset capital gains and provide an opportunity for tax savings.
 What are the different capital gains tax rates?
The long-term capital gains tax rate of zero percent applies to taxpayers with taxable income less than $74,900 for “Married Filing Joint” and less than $37,450 for single filers.
The long-term capital gains tax rate of 15 percent applies to taxpayers with taxable income between $74,901 and $464,850 for “Married Filing Joint” and between $37,451 and $413,200 for single filers.
The maximum long-term capital gains tax rate of 20 percent applies to taxpayers with taxable income over $464,851 for “Married Filing Joint” and over $413,201 for single filers.
 What is the difference between short-term and long-term capital gains and losses?
A capital gain or loss occurs upon the sale or exchange of property and equals the difference between the sales proceeds and your basis in the property, which typically is the amount you paid for it.
A capital gain or loss is categorized as short-term when the property is owned or held for one year or less before it is sold. Property held for more than one year is categorized as long-term. The holding period generally begins the day after the property is acquired and ends as of the day the property is sold.
It is important to know that net long-term capital gains qualify for the lower tax rates and net short-term capital gains are taxed at your ordinary tax rates. For this reason, if you are going to sell an investment at a gain, it may be beneficial to hold onto it for more than a year before selling so the gain can qualify for long-term treatment.
In order to determine the tax treatment of your capital gains, you will first need to net the gains and losses. Capital losses offset capital gains, but only up to $3,000 of net capital loss can be used to offset ordinary income in each year.
Excess losses are carried forward within the short-term or long-term category from which they originated to offset future capital gains until fully utilized.
Capital gains and losses are first netted against each other within their respective short-term or long-term categories. When there is both a net short-term gain and a net long-term gain, the short-term gain is taxed at ordinary rates and the long-term gain is taxed at capital gains rates.
An overall net short-term gain can result when net short-term gains exceed, or absorb, net long-term losses. An overall net long-term gain can result when net long-term gains exceed net short-term losses.
 How can losses help reduce my tax liability?
Capital losses offset your capital gains dollar for dollar. Capital gains are essentially tax-free when fully absorbed by capital losses.
You may want to consider whether your investment portfolio provides an opportunity to recognize capital losses to partially or fully offset gains. Also, since net capital gains are included in your taxable income, they factor into several tax deduction limitations and phase-outs that are based on income levels.
There are additional tax implications and variables to consider beyond the general concepts covered in this article. A detailed analysis may be necessary to determine the specific tax impact that will apply to your situation.

Saturday, September 26, 2015

5 Overlooked Variables in Retirement Planning


It wasn’t long ago that most Americans had a secure three-legged stool on which to rest their retirement concerns – a well-funded Social Security system, substantial corporate pensions with retiree health benefits and, ideally, a strong personal savings rate.
Nowadays, however, pensions aren’t what they used to be; they’ve been largely replaced by employer-sponsored plans such as a 401(k), 403(b) or 457, the reliability of which is yet to be proven. Social Security, which was never meant to be a sole income provider during retirement, is often said to be vulnerable for future generations.
Alarmingly, only 53 percent of the civilian workforce contributes to or participates in a retirement plan, according to the U.S. Bureau of Labor Statistics, with subsets like the private industry at just 48 percent. And, according to the Transamerica Center for Retirement Studies, 36 percent of baby boomers plan to rely on Social Security as their primary source of income.
“All is not lost; however, whether you’re retired, soon-to-be retired or planning on it a few decades in advance, your best move is to do something about it now,” says Marc Sarner, president of Wake Up Financial and Insurance Services Inc. (
While there are many clear factors to consider when planning for retirement – such as when to draw Social Security benefits and the possibility of long-term medical care – Sarner summarizes five variables you may be overlooking.
  • You may need a housing plan – or two. Between 2005 and 2007, U.S. home values spiked drastically in value, but shortly thereafter plummeted. Fluctuations in the housing market could impact your retirement income strategy. Your home may not provide the backup retirement income you have anticipated, Sarner says. Looking ahead, the rate of house appreciation is likely to revert closer to the long-term norms (pre-2006) of 0.75 to 1 percent per year over the rate of inflation – not double-digit annual increases, according to the Urban Land Institute.
  •  Consider the potential impact of inflation. Inflation can be experienced a little differently when you retire because you’ll likely spend money proportionately on different things. For retirees, the tendency is to spend money on things that experience a higher rate of inflation. For instance, health care, which has an inflation rate of about 8 percent – is currently two to three times greater than the overall inflation rate. 
  •  Reconsider your goals. The distribution of retirement income differs from accumulation because, once retired, you may no longer have the timeline to help you recover from the impact of a down market. You can’t control what the markets will do, or when they will do it, Sarner says. The occurrence of a market downturn, such as in the first few years of retirement, can have an impact on how long retirement assets may last. One helpful strategy is to combine growth opportunity with reliable income sources.
  •  Understand taxes in retirement. Many pre-retirees think that when they retire their taxes will be less because they are no longer working. However, many of my clients pay more taxes in retirement then while they were working.  Shocking? It’s true. The house is paid off, you have no dependents and have less write offs. Throw in your pension and Social Security income, plus RMD income from IRAs and 401ks, and now you have a real taxation problem. Proper planning can help elevate this future tax liability.
  •  Find your distribution strategy. Saving for retirement is like standing at the foot of a tall mountain and beginning the slow, steady climb towards your retirement savings goal. If you’re not prepared for a long and controlled descent, you could run out of an adequate supply of rope to make your journey safely. A distribution strategy is all about how to descend the mountain as steadily, carefully and securely as possible.
“These are summary explanations of lengthy considerations,” Sarner says. “Be sure to carefully review the many aspects of these retirement variables.”

Friday, September 25, 2015

Self-Employed? Don't Forget These Tax-Filing Tips

Calculating income taxes is a royal pain, even when your situation is uncomplicated enough that you can file a 1040EZ Form. And if you're self-employed, be prepared for extra layers of complexity. Not only must you file an annual return with numerous additional forms and schedules, you're also responsible for paying quarterly estimated taxes, which can mean having to write a pretty hefty check while waiting for your clients to pay their overdue bills.

Add in that you're also responsible for funding your own health insurance and retirement and you may start to miss having an employer manage a portion of your financial affairs. (Although many people go into business for themselves precisely to call their own shots.)

Here are a few things to remember when calculating your 2015 taxes:

First, some potentially good news for taxpayers who claim a home office deduction: You now may choose between the traditional method of calculating the business use of your home (which involves numerous calculations, filling out the onerous IRS Form 8829 and maintaining back-up records for years) and a new simplified option.

Under the new, so-called "safe harbor" method, you can simply claim a standard deduction of $5 per square foot for the portion of your home used regularly and exclusively for business, up to a maximum of 300 square feet – a $1,500 limit.

Contrast that with the traditional method where you must calculate actual expenses of your home office expressed as a percentage of the square footage your home office consumes. For example, if your office takes up 12 percent of your house, you can deduct 12 percent of your electricity bill.

A few additional details:

• You can choose either method from year to year; however, once you've elected a method for a given tax year it's irrevocable.

• Under the safe-harbor method you cannot depreciate the portion of your home used for business in that particular year.

• With the new method you can still claim allowable mortgage interest, real estate taxes and insurance losses as itemized deductions on Schedule A. These deductions don't have to be allocated between personal and business use, as under the traditional method.

You'll need to weigh whether the recordkeeping hours you save justify the potentially smaller deduction – especially if you have a large home office or considerable deductions. Suggestion: Look at last year's deduction and compare what it would have been using the $5 per square foot calculation, factoring in time spent doing the math.

A few other self-employment tax-filing considerations:

• In addition to the home office deduction, you generally can deduct many other business-related expenses, including: legal and accounting fees; professional dues and subscriptions; business insurance and licenses; professional training and education; professional equipment and software; maintenance/repairs; and business-related mileage, travel and entertainment.

• You can also deduct the full cost of medical, dental, vision and long-term care insurance premiums for you, your spouse and dependents, even if you don't itemize deductions.

• For more details on business expenses and deductions, see IRS Publication 535 ( Also visit the IRS' Self-Employed Individuals Tax Center.

Bottom line: Income taxes are often more complicated for self-employed people and good recordkeeping is essential. Unless you're an accounting whiz, consider hiring a tax professional or financial planner who specializes in self-employment issues. The penalties and fees they can help you avoid – and hidden deductions they can uncover – will probably more than pay for their fees.

Thursday, September 24, 2015

Retiring early? Plan ahead to avoid early withdrawal penalties

Imagine you have diligently saved over the years, accumulating a substantial amount of money for your retirement. If you could access your funds, you would be able to work part-time or even retire early. Unfortunately, you are younger than 59 ½ and your money is tied up in pre-tax or qualified plans. 

Retirement plans, such as IRAs, 401(k)s, SEP-IRAs or SIMPLE IRAs, allow you to save money pre-tax, thus lowering your taxable income during your working years. Some plans allow you to contribute after-tax money as well. The funds in these plans grow tax-deferred until retirement age. After 59 ½ , you can begin taking distributions, paying only ordinary income tax on the taxable portion of your withdrawals. If you choose to access your money early, the IRS imposes an early distribution penalty of 10 percent on the withdrawal in addition to the ordinary income tax due. Depending on your current tax bracket, an early distribution can cost you 40 to 50 percent of your withdrawal.

While you cannot avoid paying taxes on your distribution, there are ways you can avoid the early withdrawal penalty that is levied on the gross amount of your withdrawal prior to age 59 ½ . 

Roth IRAs are funded with after-tax money, so they are more flexible than other pre-tax retirement plans. You contribute money after-tax, and the earnings grow tax free for your retirement years. Direct contributions are always accessible, penalty- and tax-free, while earnings can be accessed penalty- and tax-free after age 59 ½ . However, to contribute to a Roth IRA, your adjusted gross income must be less than $131,000 for single or $193,000 for joint filers.

How do you access your retirement money early if either you don’t have or are ineligible for a Roth IRA? It takes a little planning and five years, but it is possible. The Tax Increase Prevention and Reconciliation Act of 2005 repealed the income limits on Roth conversions starting in 2010. Therefore, many investors who were above the income limits for contributions were able to convert money from pre-tax retirement savings plans into Roth IRAs. A conversion is a taxable event, but the true benefit to a conversion is the tax-free growth potential and tax-free withdrawals in retirement. However, Roth IRAs also allow you to withdraw converted money penalty- and tax-free after it has been in your Roth for five years. 

If you know you will want to pull money out early, you could begin converting a set dollar amount each year to a Roth, paying the tax due, with funds from outside of the pre-tax account, at the time of the conversion. Roth conversions are not an all-or-nothing deal. You can do it slowly over the years, only converting amounts which you can afford to pay the taxes on. Furthermore, each conversion amount has its own five-year time period. So with multiple conversions, there may be multiple five-year periods underway at once. Earnings on the converted funds should remain in the account until age 59 ½ . Otherwise, withdrawals of earnings will incur the 10 percent early withdrawal penalty.

While early withdrawal penalties will vanish at 59 ½ , you don’t always have to wait that long to access your retirement funds. Typically, the longer funds grow tax free in a Roth, the greater the benefit should become.

Wednesday, September 23, 2015

Start year-end tax planning now

It may seem a little early to start thinking about the end of the year, but before you know it, the leaves will fall and you will be rushing to buy year-end holiday gifts. That’s why this is a great time to start year-end planning. Don’t wait until you are rushed and forced to make a knee-jerk decision. Start now to make decisions when you have the time to accumulate the necessary information.
Like everything else in the financial and legal world, there is no one piece of advice that fits all. Everyone’s situation is different and what may be good for your next door neighbor or best friend, is not necessarily good for you.
It is important to take information and apply it to your individual situation. In that regard, one area that many people should consider before the end of the year, is a Roth conversion of some or all of their traditional IRAs.
The main benefit of this transaction is two-fold. The first is that money in a Roth IRA grows tax free versus money in a traditional IRA that grows tax deferred. In addition, money in a Roth IRA is not subject to required minimum distribution rules at 701/2.
Nothing comes without a cost. The cost of converting money into a Roth IRA is that you are paying taxes on the amount that you are converting. You will always pay taxes on the amount, however, by converting you are paying the tax earlier
The rules I have lived by in deciding whether to convert existing IRA money into a Roth IRA are:
1). By converting the money and paying the tax on the amount converted, it won’t throw you into a higher tax bracket.
2). You have the money (other than the money you are converting) to pay the additional tax liability.
3). You won’t need the money for at least five to seven years.
If you meet these three rules then a Roth conversion would make sense. Contact your IRA custodian and they can assist you.
Other year-end tax moves that make sense are to accelerate itemized deductions into this tax year or to delay them until next year. For example, if you are charitable in nature and you traditionally make year-end charitable contributions, do those deductions make sense this year or do you delay them until next year? There’s no right answer because it all depends upon your individual situation. If you are not itemizing your deductions this year, then certainly you want to delay those deductions until next year. On the other hand, if you are itemizing your deductions and you’re in a higher bracket this year than you anticipate you’ll be next year, then it pays to take those deductions this year.
Before you know it, 2016 will be here. If you plan to do any year-end planning, don’t procrastinate – start the process as soon as you can. By giving yourself the time to study your situation and talk to your professionals, you’ll make the right decision for yourself.
Good luck.

Tuesday, September 22, 2015

Minimize the Tax Drag on Trusts

Estate taxes are often the central focus of an estate plan because they can prove to be the heaviest drag on a legacy.  A common approach is to create trusts to capture and leverage an individual’s estate tax exemptions.  While this tactic can move the plan two steps forward, accelerated trust income tax brackets are often waiting to drag it two steps backwards.  The internal taxation of trusts can limit their efficiency, and estate planners should think about taking a leaf from the playbooks of protection and retirement income planning, especially when the goal of the trust is to accumulate and protect trust capital and provide an income to the trust beneficiary that he can’t outlive. 
Long-Term Impact
When taking clients through the estate-planning process, it’s important to discuss the long-term impact of trusts that the client may implement today.  The income taxation of trusts is an important factor in assessing what that impact will be.  When an individual establishes a grantor trust, he continues to pay the tax on any income generated by the trust investments.  But a trust with a deceased grantor, such as a credit shelter trust or a funded irrevocable life insurance trust, will be taxed as non-grantor trusts, meaning that the trust is a tax-paying entity, subject to the compressed trust income tax brackets.  Those brackets can have a striking impact.  In 2015, an individual won’t reach the top tax bracket until he has $413,200 in income.  However, trusts reach that same bracket level at a mere $12,300 of income.  Clients taking advantage of this type of trust for estate tax savings may be leaving their survivors an income tax problem.
Dealing With Internal Trust Taxation
There are several ways to deal with this burdensome internal trust taxation:
1) Terminating the trust at the grantor’s death, 2) Distributing all the income out to trust beneficiaries and allowing them to pay the taxes at their individual rates, or 3) Simply reinvesting inside the trust and absorbing the additional income taxation.
Any of the three options may be sensible when the trustee takes into account the many possible dictates of the trust agreement, the needs of the beneficiaries for regular income or liquidity, how vulnerable they may be to attempted attachment by creditors, the trust’s risk tolerance and its time horizon.
Annuities Owned By Trusts
In addition to the three options outlined above, there’s a fourth potential option.  Clients and financial professionals recognize that tax-deferred annuity products are important retirement income vehicles, and these are a popular choice among clients looking for tax-deferred growth and income when their working years are over.   Annuities have inherent strengths that can provide value in many spheres.
In general, the internal growth of a non-qualified annuity is income tax-deferred.  Generally, the owner of the annuity pays ordinary income tax on gain only when it’s distributed from the annuity contract.  This tax deferral feature alone can make annuities a logical choice to be owned by a trust.  It can provide a trustee with the freedom to select growth oriented sub-accounts inside the annuity without incurring a heavy income tax drag.  There’s also a wide variety of annuities available that have a comprehensive menu of options.
As noted, the choices facing estate-planning professionals often involve trade-offs, and admittedly, an annuity can have its drawbacks. To derive the benefits of tax deferral, the owner gives up the ability to treat any of the growth as a capital gain.  Instead, the gain on an annuity is taxed as ordinary income.  With a few exceptions, there’s a 10 percent penalty on gains withdrawn before age 59½.  And, unlike capital assets such as real estate, stocks or bonds, there’s no step-up in cost basis at the owner’s death.  When the asset is passed to an heir, so is the built-in income tax liability in the form of Income in respect of a decedent (IRD).  At present, the Internal Revenue Service allows for a beneficiary to stretch out the withdrawals on an inherited annuity contract, but the beneficiary must still begin receiving distributions in the year following the annuitant’s death.  Finally, it’s important to note that annuities tend to have higher fees than other financial products and that additional riders ensuring certain rates of return or return of capital will also come with a cost and impede the overall rate of return. These are all factors a trustee must balance against the potential advantages of owning an annuity.
Despite some of the hurdles, a trust owning an annuity can present a unique opportunity simply because trusts can be established to have at least two generations of beneficiaries. Taking advantage of the longer life expectancies of younger beneficiaries can result in substantial tax deferral.  If the trustee names a member of the younger generation as the annuitant on a contract, it may be possible to defer distributions across two generations or more, reducing the impact of both ongoing trust income taxation and IRD at the death of the older beneficiary.
The opportunity is perhaps best illustrated through an example of a credit shelter trust (CST) created to preserve the decedent’s federal estate tax exemption, when a step-up in cost basis at the surviving spouse’s demise isn’t a concern.  The trust has two classes of beneficiaries: (1) the surviving spouse is the income beneficiary, and (2) the grantor’s children are the remainder beneficiaries.  For a variety of reasons, the spouse may prefer not to receive income from the trust.  He may simply not need it or may expect to be in a lower tax bracket after retirement and prefer to defer the income until then.  The spouse may also wish to leave a larger balance of funds to the remainder beneficiaries. 
If the trust holds capital assets, the trustee can always distribute the trust income to the spouse if he needs it, but this example assumes that the spouse prefers to allow the income to be accumulated in the trust.  In that case, the account will be subject to capital gains, ordinary income tax and the 3.8 percent Medicare surtax.
To the extent a trust agreement gives the trustee the discretion to withhold or accumulate income, if the trust owns an annuity, the trustee will have control over its income distributions.  The trustee also has flexibility to exchange and rebalance the annuity’s sub-account allocations without triggering any income or capital gains tax, which allows for the trustee to make adjustments over time and respond to changes in the market.
Now consider the effect if the trustee names one of the trust’s remainder beneficiaries as the annuitant.  The surviving spouse is still the primary beneficiary of the trust and can therefore receive distributions necessary.  If the spouse doesn’t require the income, the annuity’s value will grow for the next generation.  When the surviving spouse eventually passes away, if the annuity carrier allows the trustee to distribute the contract to the annuitant in kind, there will be no taxable event at that time and no disruption in the tax deferral.  Keep in mind that the availability of this option will depend on the policy of the issuing company and the terms of the contract.  
When the annuity is passed in kind to the annuitant, if he doesn’t need immediate access to the funds, those monies can continue to grow tax deferred.  This creates potential for two generations of tax-deferred growth. If the average tax-deferred rate of return, net of fees, were 3.4 percent, the annuity would grow to $3,809,039 over the two generations .1 In a taxable trust account, subject to a top tax rate of 39.6 percent plus the 3.8 percent Medicare surtax, it could take as much as a 6 percent rate of return to achieve the same result. At five percent, the tax-deferred funds would grow to $7,039,989,2 and at six percent to $10,285,718.3
While the potential tax deferred growth is compelling, clients must be made aware that the beneficiaries will be facing ordinary income tax on the gain in excess of the initial contribution of $1 million.  However, they may elect a non-qualified stretch option, allowing them to take distributions over their life expectancy rather than as a lump sum.  Again, if the beneficiary doesn’t need the income, he may decide to take only the required minimum distributions. That means that a third generation could enjoy tax deferral on a large portion of the funds. With 20 more years to grow, the impact could be even more substantial.
Consider Full Range of Choices
Of course, there are countless types of trusts, and they all pose different planning issues, so there should never be a one-size-fits-all choice or a default funding vehicle.  Ultimately, a trustee with fiduciary duties should marshal the available resources—competent tax, legal and investment advice, as well as his independent judgment—in deciding what’s permissible and prudent.  Financial professionals can best help their clients make successful decisions by considering the full range of choices and by including income taxation as one of the risks to assess in the decision-making process.  This is particularly relevant when the individuals involved care about passing a legacy on to future generations.  The most potent leverage comes when the structure and the funding are in balance and meet the clients’ goals.

Monday, September 21, 2015

Does Tax Loss Harvesting work for Capital Gains and Losses?

Yes, but not for everyone.
When markets drop a popular thing to do is swap losing holdings in non-retirement accounts to generate capital losses. These maneuvers are definitely something we consider but there are several situations where the value of these trades is suspect. Frequently overlooked are that some losses aren’t useable and in the process of harvesting the losses, cost-basis is reset to a much lower amount possibly increasing future gains.
If you buy “ABC” for $50,000 and ABC drops 20 percent, you may opt to “harvest” the loss by selling ABC for $40,000 and buying a similar holding “XYZ” with that $40,000. Because XYZ and ABC are similar, your basic investment plan is intact but you have a $10,000 “realized” loss for tax purposes. This can be a smart move that saves tax dollars but not in all cases.
Tax law dictates that the loss first be used to offset capital gains. That’s nice but the tax rate on long term capital gains for taxpayers in the 15 percent marginal bracket or lower is zero so the loss may have no value to such taxpayers. Future gains will actually be greater in this case.
If the loss exceeds the year’s gains, you can use $3k against your ordinary income on your current year 1040. The value of that depends on your marginal tax bracket. You would then “carry forward” $7,000 of losses to the following year.
You also now own XYZ with a basis of $40,000. If XYZ appreciates to $50,000 and is sold, you incur a $10,000 gain. If the gain is not offset by losses or loss carryforwards, the gain is taxed at the then prevailing capital gain rate.
Real life isn’t as simple as this example. Most people have several holdings and multiple tax lots. Often, people face multiple possible tax rates through their investment time horizon. All this means multiple planning opportunities, or pitfalls. In general, the higher your current bracket relative to your anticipated future bracket, the more likely the tactic will pay off.
Tax-loss harvesting is often presented as a short-term tactical decision but really it should be considered as part of a long term strategic plan.

Sunday, September 20, 2015

Health Savings Accounts Growing, Especially Among the Better Paid


THE number of people with health savings accounts has ballooned, but higher-income families are much more likely to fund the accounts, a new analysis found.

The number of health savings accounts, or H.S.A.s, has been growing by about one million a year, reaching more than 6.5 million in 2012, according to research published this week in the journal Health Affairs. The analysis covered eight years, although the accounts have been around for more than a decade.

Health savings accounts let consumers save and pay for medical care, free of federal income taxes. Balances are carried from year to year, and consumers can often invest the money for tax-free growth. The accounts are not available to everyone, however. They must be used with a specific type of health insurance plan with a high deductible (at least $1,300 for a single person in 2015).

Adoption of H.S.A.s by workers at the biggest employers, while still relatively limited, nearly tripled in the eight years covered by the study, the researchers found. Typically, the health plans linked to the accounts offer lower premiums, because you will pay more out of your own pocket before meeting your deductible.The new study is the first H.S.A. analysis based on actual tax records, rather than on surveys of consumers and businesses, said Lorens Helmchen, associate professor at the Milken Institute School of Public Health at George Washington University and the report’s lead author. Researchers examined federal income tax data to analyze the number of filers who reported having an account. (Because contributions to the accounts are not subject to federal income taxes, they require the filing of a special tax form.)

H.S.A.s offer the prospect of significant tax savings. Contributions are deducted from pretax income, and any contributions you make from personal funds are tax-deductible — even if you don’t itemize deductions on your return. Withdrawals aren’t taxed either, as long as the funds are used for eligible medical costs.

The researchers found that high-income and older tax filers both established and fully funded their H.S.A.s at least four times as often as low-income and younger filers. (It remains to be seen, the study noted, whether the Affordable Care Act changes that dynamic. Many plans sold on government exchanges offer H.S.A.s, but the study ended before the marketplaces began operating.)

Timothy Hayes, a financial planner near Rochester, said the accounts might be attractive to consumers who have funds to invest longer term, because they can be used to pay not only for medical care in retirement but also for costs like long-term-care insurance premiums.
Mr. Hayes said he advised clients that, if they could, they should pay for current medical costs using other funds, and let their H.S.A. contributions grow for future use. Even though it’s convenient to pay for medical care with the debit card that most health savings accounts provide, he said, try to resist the urge: “You’ll be happy to have that money, when you’re older.”

Here are some questions and answers about health savings accounts:
■ What is the maximum contribution to a health savings account?
For 2015, the maximum for an individual is $3,350, and $6,650 for a family. (Optional contributions from an employer count toward the total.) In 2016, the cap for an individual remains the same, while the amount for a family will rise by $100, to $6,750; the lack of a big change is because of “tepid” inflation, according to the Society for Human Resource Management.

■ Can I make “catch-up” contributions to my H.S.A.?
Yes. If you are 55 or older, you can add an extra $1,000 a year to your account.

■ Is an H.S.A. the same as a health care flexible spending account?
No. The accounts sound alike, but have different rules. For instance, you can’t take an F.S.A. with you, if you change jobs.

Saturday, September 19, 2015

Tips to Help You Plan for the Next Tax Season

The April 15th tax deadline is gone, your taxes are done, but why should you even still have an interest in your taxes?
You don’t have to jump into tax planning at this very moment, but you should be aware of some things that you can do throughout the next year so you will get the maximum tax refund possible next year. The 6 tips below will help.
2016 Tax Year Tips:
  • Get and Stay Organized. Your taxes are already filed, but staying organized will make filing next year much easier. Create a file for financial records and other important documents. That way you will be ahead of the game next year at tax time.
  • Take A Closer Look At Your W-4 Withholding. Was your tax refund a big one this year? You should consider adjusting your withholding. These are the taxes taken from your salary by your employer. You can update them by re-filing your W-4 form with the payroll department. WithTurbo Tax W-4 calculator, you can estimate your exemptions and update your W-4 form anytime during the year.
  • Donate to Charities before year’s end.  When filing your taxes next year, you can minimize your tax liability by making charitable contributions in money or goods. Made use of TurboTax Its Deductible to track your charitable donations all through the year. The app will convert your donations into tax deductions and will make importing the appropriate info into Turbo Tax easy at filing time.
  • Contributing to retirement funds to reduce taxable income. Planning for your retirement can help to reduce your tax burden for next year. For every dollar you contribute to your 401(k) or Traditional IRA you will get an equivalent reduction in your earned income when filing your taxes. For the year 2015 you are allowed to contribute $18,000 to your 401K and if you are over 50 years old that increases to $24,000. For your traditional IRA you can contribute up to $5,500 or $6,500 if you are 50 or older.
  • Di you pay tax penalty for 2014? Then sign-up for healthcare. Did you pay a tax penalty in 2014 for not having health insurance? Then you have until the deadline of April 30 to enroll in the Marketplace plan unless you have gone through a special life event. You will avoid having to pay the tax penalty next year, which is expected to go up to $325 for an adult and $975 per family or as much as 2% of your income, whichever figure is bigger.
  • Update financial information in the Health Insurance Marketplace. You will need to update your financial details in the Marketplace if you purchased insurance during the previous Open Enrollment and you got a tax credit to help with insurance coverage fees. By doing this you are getting the maximum allowable help you are entitled to while not having to repay extra tax credits, which you will not be eligible for next year.

Friday, September 18, 2015

How to get more income from highly appreciated stocks

As folks live longer and their stocks increase in value, retirees look for ways to increase their income to maintain their standard of living and sometimes provide cash gifts and support to their children and grandchildren. I think that at every investment conference I have attended in the past few years, one of the main presentations centered around how to provide income in our current low-income environment and still protect against risk.
I’ll discuss three ways to increase your income: sell some of your stocks, borrow against them and use a bona fide charitable gifting technique.
1. Sell stocks: You may not want to sell any of your highly appreciated stocks because you want to keep the dividends and defer the capital gains tax. You know that if you defer those capital gains until you die, your beneficiaries will enjoy a new, stepped-up cost basis, eliminating that tax. (Not true if the stocks are in a bypass — aka exemption — trust). You should ask your tax professional what tax you would have to pay on long-term capital gains. You might be pleasantly surprised. Capital gains tax depends on your income. Although the maximum rate is 20 percent (not including the 3.8 percent Net Investment Income Tax), most taxpayers actually have a 0 percent to 15 percent federal tax rate on their long-term capital gains.
2. Borrow against your stocks: For most retirees, this option won’t make financial sense. The interest rate you pay will probably be twice the rate of dividends that you are earning, meaning you are losing money. And if you die with the loan still in force, your estate will have to pay it off. Borrowing with stocks as security, usually done through your broker using a margin account, is OK for a short-term loan, but never a good idea for providing income over a long period of time. And the IRS won’t let you deduct the margin interest unless you are using the loan proceeds to buy investments.
3. Charitable Remainder Trust (CRT). An excellent way to provide income from appreciated stocks and avoid capital gains tax is to set up a Charitable Remainder Trust (CRT). A CRT is an irrevocable trust. You give your stock to the CRT. The CRT sells the stock, pays no tax and pays you an annual income. When you die, the money in the CRT goes to charity. The advantages of the CRT are: (1) A higher annual income than you can get now, (2) an immediate tax deduction for the gift, (3) the removal of the stock from your estate for estate tax purposes, and (4) the gratification of giving to the charity or charities of your choice while you are still alive. Ask your attorney, your favorite charity or your local community foundation.

Thursday, September 17, 2015

Annuities Can Be a Useful Estate Planning Tool

 Annuities are regular payments that insurance companies provide in return for contributions, typically to a life insurance policy. For some, annuities represent a valuable estate planning tool, providing a way for retired people to ensure a regular income even if they live a long life.
"Annuities can be helpful in estate planning, but it is important to understand the differences between the types of annuities, as well as their limitations. They should typically be considered for people who have maxed out their IRA and 401(k)s but are still looking to save aggressively for retirement."
Single-premium immediate annuities are the most basic type of annuity, in which the insurance company pays a set sum of money for a given period of time. Other types of annuities include variable annuities, in which payouts are based on investment funds' performance, and indexed annuities, in which payments are tied to a stock index. Some variable annuities allow owners to purchase a rider that guarantees a minimum annual payout.
Variable and indexed annuities now represent the majority of annuities sold, at about 80 percent of all annuities. These types of annuities can be useful, but they also tend to be complex and can be risky. For example, if the value of the investments tied to the annuity decreases, the annuity's cash value can decline as well, meaning that a minimum payout rider does not truly protect against loss. Indexed annuities can be particularly troublesome, as they provide no guaranteed income.
One of the biggest advantages of annuities is that the assets accumulate tax-deferred, as in a traditional retirement account. Although annuity contributions are not tax-deductible, there is no limit to the contributions a person can make. For individuals who have already made their maximum contributions to their 401(k) and IRA, an annuity may be a strong choice.

Wednesday, September 16, 2015

What Is a Trust, and Why Should I Have One?

Trusts can be a great way to update an estate plan, whether within a will or as a separate estate-planning tool. 
Trusts have a reputation for being something that most people don't have to worry about, with most seeing a trust as a vehicle for the ultra-rich to protect their assets from taxes and other financial threats. In reality, though, trusts are tools that just about anyone can use to achieve worthwhile financial goals. Still, the legal complexity of the estate planning world has left many people uncertain about what a trust is, let alone how to use it. Let's take a closer look at trusts to try to answer the question of what they are and how they can help you and your family.
What is a trust?In legal terms, a trust enables a person to separate the legal ownership of property from the beneficial enjoyment of that property. Put more simply, a trust gives responsibility for managing and preserving trust property to a person or entity called the trustee. Meanwhile, the beneficiaries of the trust are the ones who actually get to receive trust assets, according to whatever terms the trust establishes for distributions.
Behind that simple concept, though, trusts are available to serve a wide range of different goals. For instance, here are just a few of the many different types of trusts and how people use them:
  • Revocable trusts, also known as living trusts, enable those who create them to ensure the proper management of their assets both during their lifetime and after their death. The person creating the revocable trust can change it at any time, but after death, the instructions set forth in the trust document guide the trustee's future actions.Many people use revocable trusts as an estate planning tool to pass assets to heirs without undue publicity or the need to go through a probate court proceeding, saving on costs and administrative hassle.
  • Testamentary trusts are created in a person's will. They don't avoid probate, as a court proceeding is necessary to provide the initial funding for the testamentary trust. As a backup for situations in which the protections of a trust are useful, though, testamentary trusts allow for flexibility to handle different situations that can arise.
  • Irrevocable trusts can be used to make gifts in a manner that provides subsequent protection from creditors and estate taxation. Irrevocable trusts are often used to hold high-value life insurance policies, with the trust setup helping to keep the insurance proceeds out of the taxable estate of the insured person.
  • Special needs trusts can help family members with disabilities preserve their eligibility for government assistance while still making financial assets available for supplemental use as necessary to ensure the beneficiary's well-being. Special provisions ensure that any trust money used for the beneficiary won't jeopardize benefits available under programs like Medicaid and Supplemental Security Income.
  • Charitable trusts allow you to make a gift to charity while still retaining an interest in the property you donate. Charitable remainder trusts involve your keeping a stream of income that continues for a set period or for the remainder of your life, with the charity receive any remaining funds at your death. These trusts can give you income-tax benefits from the value of the donation even though you still get income from the assets within the trust.
  • Various other technical trusts are used for estate planning purposes. Credit shelter trusts are intended to preserve the estate tax exemption of a deceased spouse for future use, while a qualified terminable interest property or QTIP trust allows a spouse access to funds while preserving their eventual distribution to children or other heirs. A qualified personal residence trust or QPRT can allow you to transfer an interest in your home to family members during your lifetime in a manner that can produce extensive gift and estate tax savings.
As you can see, trusts are useful for a number of different situations. In essence, though, they all boil down to a single benefit: guaranteeing that your assets will be used as efficiently as possible to meet your wishes and provide for yourself and those you love.
Trusts aren't just for the rich. With many different purposes for trusts, you might well find that you could benefit from establishing a trust for yourself or your family

Tuesday, September 15, 2015

How Do I Form a partnership for tax purposes

A business operated by two or more owners can elect to be taxed as a partnership by filing Form 8832, the Entity Classification Election form. A business is eligible to elect partnership status if it has two or more members and:
  • is not registered as anything under state law,
  • is a partnership, limited partnership, or limited liability partnership, or
  • is a limited liability company.
Publicly traded businesses cannot elect to be treated as partnerships. They are automatically taxed as corporations.
Form 8832 allows a business to select its classification for tax purposes by checking the box on the form: partnership, corporation, or disregarded. If no check-the-box form is filed, the IRS will assume that the entity should be taxed as a partnership or disregarded as a separate entity. An LLC that makes no federal election will be taxed as a partnership if it has more than one member and disregarded if it has only one member. An LLC must make an affirmative election to be taxed as a corporation. The IRS language on Form 8832 uses the term “association” to describe an LLC taxed as a corporation.
Form 8832 has no particular due date. There is a space on the form (line 4) for the entity to note what date the election should take effect. The date named can be no earlier than 75 days before the form is filed, and no later than 12 months after the form is filed. It is most important to file Form 8832 within the first few months of operations if the entity desires a tax treatment that differs from the tax status the IRS will apply by default if no election is made.
A few businesses do not qualify to be partnerships for federal tax purposes. These are:
  1. a business that is a corporation under state law,
  2. a joint stock company (a corporation without limited liability),
  3. an insurance company,
  4. most banks,
  5. an organization owned by a state or local government,
  6. a tax-exempt organization
  7. a real estate investment trust, or
  8. a trust.
Although these businesses cannot be partnerships, they can be partners in a partnership (they can join together to form a partnership).
Of course, whether your business is best operated as a partnership, as a corporation or as another type of entity should not only be driven by short-term tax considerations. How you envision your business will develop over time, whether your business is asset or service intensive, and what personal financial stake you plan to take, among other factors, are all additional factors that should be considered.